2017-06-01

Good Magicians Use Sleight of Hand

Or maybe making currency manipulation disappear is much harder than it seems. From the view of yen and euros, the spike in the yuan doesn't look like much at all. From the view of volatility in the yuan and the seeming determination to hold the line at 6.89, it looks like a big deal. If one believes in the strong manipulation argument (China sets the value of the yuan and everything else is for show), then maybe China realized it had allowed too much devaluation and was falling out of line with yen and euros. Although China doesn't want depreciation expectations hardening further, in the recent past the yuan was tracking the dollar more closely on dollar weakness, and less so on dollar strength.

Despite the ongoing fireworks, there was some good news for Yuan traders. In a note released overnight, UBS wrote that the CNY has appreciated notably against the USD in the past couple of days - a bit of an understatement - and added that "we see this as playing a bit of catching up following recent USD weakness. CNY has actually depreciated against the basket this year despite strengthening against the USD. Poor liquidity meant CNH moved up more. We now expect CNY to stay strong and not moving beyond 7 against USD this year."

This final bit isn't reassuring:

Helped by exchange rate stability and controls on outflows, China's FX reserves will likely stay above $3 trillion in 2017. As USDCNY has stabilized, carry-trade or arbitrage activities by corporate and financial institutions have come down substantially – even through the underlying desire by Chinese corporates and households to diversify into foreign assets remain. Onshore FX purchase activity by households also seems to have calmed down. As a result, we now see China's FX reserves staying above $3 trillion in 2017, despite the fact that its current account surplus will likely shrink.